In accounting, the matching principle states that revenue should be recorded when it is earned, and expenses should be recorded when they are incurred. When you purchase a piece of equipment, it may be used for several years. To allocate the expense of the equipment to each period of its use, you use a technique called depreciation.

Depreciation

Depreciation is a method of allocating the cost of equipment over several accounting periods. The most common method of depreciation is straight-line depreciation, which involves depreciating the equipment an equal amount over each period. First estimate the service, or useful, life of the asset. Next, estimate the salvage value, or market value, at the end of its service life. Then subtract the estimated salvage value from the cost of the asset and spread the remaining amount equally over its remaining service life. For example, if you purchase a van for $20,000 with an estimated service life of 10 years and salvage value of $3,000, it would depreciate $1,700 each year ($20,000 - $3,000 = $17,000/10 = $1,700).

Entering Depreciation Expense

In a double-entry accounting system, accounts are entered in either a debit or credit column. An increase in an asset or an expense is entered in the debit column; a decrease in an asset is entered in the credit column. Use the accumulated depreciation account to record the amount an asset has depreciated. For example, if your asset depreciated by $425 during the current quarter, enter $425 in the debit column for depreciation expense and $425 in the credit column for accumulated depreciation. This entry records the $425 expense in the current period as well as the $425 depreciation to the asset.

Physical Life Versus Service Life

The physical life of an asset is not the same as its service life. The service life of an asset is how long it will be useful; its physical life is how long it will be functioning. One factor that affects an asset's service life is that the asset simply wears down over time. Another factor is its inadequacy: If your production needs increase, the equipment you currently own may be inadequate. Lastly, the asset may be obsolete. For example, you may have a 10-year-old computer that still functions but is not worth keeping.

Other Ways to Allocate Expense

Depreciation is the method used to allocate the cost of buildings and equipment; other types of assets use different methods of cost allocation. Depletion is used to allocate the cost of natural resources such as timber or coal. Amortization is used to allocate the cost of something intangible, such as a patent. Each of these methods matches the expense of an asset to the period it is being used in.

About the Author

Shane Blanchard began writing in early 2010 and has tutored students in accounting, business finance and microeconomics. He graduated from the University of North Carolina, Charlotte with a Bachelor of Science in accounting. Prior to graduating from UNC, he graduated from Mitchell Community College with an Associate of Applied Science in business administration. Blanchard is a licensed property and casualty insurance agent.